Meadow Transport Ltd. is considering two plans for raising $4,000,000 to expand operations. Plan A is to borrow at 9 percent, and Plan B is to issue 400,000 common shares. Before any new financing, Meadow Transport Ltd. has net income after interest and income tax of $2,000,000 and 400,000 common shares outstanding. Management believes the company can use the new funds to earn income of $840,000 per year before interest and taxes. The income tax rate is 40 percent.

Required

Analyze Meadow Transport Ltd.'s situation to determine which plan will result in higher earnings per share. Use Exhibit 15-8 on page 941 as a guide.

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EXHIBIT 15-8 Earnings-per-Share Advantage of Borrowing versus Issuing Shares Plan 2: Plan 1: Borrow $1,000,000 Issue $1,000,000 at 10% of Common Shares Net income after interest and income tax, before expansion Project income before interest and $600,000 $600,000 income tax 300,000 100,000 200,000 300,000 Less: Interest expense ($1,000,000 × 0.10) Project income before income tax Less: Income tax expense (40%) Project net income Total company net income Earnings per share including expansion: Plan 1 ($720,000 ÷ 200,000 shares) Plan 2 ($780,000 ÷ 300,000 shares) 300,000 120,000 80,000 120,000 180,000 $780,000 $720,000 3.60 2.60